Is the stock market fair?

Back in February, I forecast that the Dow would end 2013 at 17,000. The bad news is that it’s way short of that target. But there are two pieces of good news: It is up 18 percent since the beginning of 2013, and even though it hit a record of 15,498 on July 12, nobody seems to care, which is good, because lack of interest suggests that stocks are far from bubble territory.

I do not regret my regular investments in a stock index fund. The S&P 500 has risen at a 23 percent annual rate since March 2009 and is up 17.8 percent this year through July 12. And while the S&P 500’s price/earnings ratio of 19.4 is above the long-term average of 15.4, it is way short of the P/Es of 45 and 65 that preceded the 2000 and 2008 bubble bursts, respectively.

Meanwhile, Wall Street is in a tizzy because New York’s attorney general, Eric Schneiderman, banned some news outlets’ practice of selling so-called high frequency traders – who use computers to trade securities for an average of 11 seconds -- early access to market moving news. It sounds like those news outlets were selling inside information.

But the most interesting part of the story to me is that the hedge funds trying to game the market are doing much worse for their investor, than simply buying an S&P 500 index fund. (Though by taking fees of 2 percent of the assets they manage and at least 20 percent of annual investment profits, top hedge fund owners regularly rake in over $1 billion a year.)

But both the news providers and the high frequency traders are competing in markets where it is impossible to get an edge that would make the business profitable. In case you haven’t heard, ThomsonReuters agreed to stop taking money from high frequency traders in exchange for a two-second head start on its University of Michigan Consumer Sentiment Index.

Buying that information had been a sure source of gains for high frequency traders. If they knew two seconds before the rest of the market that consumers were feeling more pessimistic than the market thought, the traders could profit from betting that stocks would fall – and they could bet on a rise if their two-second head start revealed better-than-expected consumer sentiment.

And after Mr. Schneiderman banned the practice, trading in advance of the release of that information plummeted. According to the New York Times, in the 10 milliseconds before release of that data on July 12, only 500 shares of a leading S&P 500 exchange-traded fund traded – that was over 99 below the 200,000 shares of that fund that traded at the same time in 2012 when that two-second head start was considered acceptable.

Since so many traders were engaging in this practice, it was hard for any one of them to get an edge. And it appears to the average person that giving some traders early access to market-moving information is akin to insider trading. However, since that information was obtained legally – through a contract between ThomsonReuters and the traders – it did not violate the strictures of insider trading laws, according to the Times.

To be illegal, those high frequency traders would have had to have stolen the Consumer Sentiment reports and traded on them. If you have seen the 1983 movie Trading Places, with Eddie Murphy and Dan Akroyd, you know that it featured a commodities trading strategy that hinged on an elaborate plot to steal a frozen orange juice crop report from the Department of Agriculture before it was released to the market. That would have been considered insider trading.

But the struggle for advantage is not limited to hedge funds.

Publishers desperately need extra cash any way they can get it. After all, with news moving from the dead-tree format to the online medium, the money to be made from most news is plunging. After all, rates on Internet advertising are much lower than those lucrative weekly circulars and the former gold mine of print classified and employments ads.

ThomsonReuters had a monopoly on information that was valuable to traders who could profit from early access. And it decided to cash in on that increasingly rare competitive advantage by selling access to the information two seconds before everyone else got it.

But despite their efforts to get an edge through such practices, hedge funds are both ripping off their investors with high fees and falling way behind the market averages in performance. According to a May Goldman Sachs report, hedge funds lag the S&P 500 index by roughly 10 percentage points and by the end June, had gained just 1.4 percent for 2013.

Why would you pay those high fees I mentioned earlier for such lousy performance when you can pay a fraction of 1 percent for much higher returns in an S&P 500 index fund?

The simple – and unheralded – reality is that the last four years have been the best time in at least seven decades to own the average stock. That seems fair to me.

Peter Cohan of Marlboro heads a management consulting and venture capital firm, and teaches business strategy and entrepreneurship at Babson College. His email address is peter@petercohan.com.

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